The Dow Jones Industrial Average Index

Video Transcription:

Hello traders. Welcome to the stock trading course and the second module – stock market indices.

In this lesson, I’m going to go through the Dow Jones Industrial Average and we’re going to start by defining what the Dow is. The Dow Jones Industrial Average is one of the oldest and most well-known indices in the world. It was first introduced in May 26th 1896. It includes the stocks of the 30 largest and most influential companies in the United States. It represents about a quarter of the value of the entire US stock market. This is huge.

Now, let’s break down the Dow Jones Industrial Average. The Dow is price weighted. This means that it was originally priced by adding the per share price of every stock and dividing it by 30 which is a very, very easy way to calculate the price of this index but in today’s market, this is not the case. Today, its price calculation is more complex due to stock splits and spin offs, but it really doesn’t matter how this average or how this index is calculated. But it’s important to know that today, it’s more complex than just adding the per share of every stock and dividing it by 30. A percent change in the Dow should not be taken as a definite measure of movement in the stock market and this is because the index is price weighted and a $1 move in a $100 stock will have the same effect as a $1 move in a $35 stock. Even though one stock has moved by 1% and the other by 2.85%, they will have the same effect on the index.

Now, let’s understand what the Dow really is. A change in the Dow represents a change in the investor’s expectations of the earnings and risks of large cap companies and because of this, the…and because of the expectations for large caps differ from mid and small caps, the Dow should not be used to represent sentiment in those areas. This means that the Dow should only be used to represent sentiment in large cap stocks and if you are a mid-cap trader or a small cap trader or even a penny stock trader, you should definitely not look at the Dow to find the market sentiment and help you on your trades.

Now let’s look at the structure of the Dow. Industrials represent 20.41% of the index, consumer services represent 16.36% of the index, technology – 15.58%, healthcare – 11.45%, financials – 11.13%, oil and gas – 10.92%, consumer goods – 6.16%, telecommunications – 4.73% and basic materials – 3.26%. So if you’re looking to trade telecommunications, just remember that they represent only 4.73% of the entire Dow but if you’re looking at trading consumer services and technology, you should definitely look at the Dow to find the overall the overall sentiment in those areas.

Now let’s have a look at a chart of the Dow Jones Industrial Average. Okay, so here is the Dow chart of the daily time frame and let me just zoom it in so we can look at a much larger representation of this price action. Okay, so you can see that what we are looking at is at the top, well the top right corner of the chart and it’s really not representative of the entire sentiment of the Dow since mid-2009. As you can see, we were in a very strong bear market from the end of the end of 2007 until the beginning of 2009 and then we started on a very strong boom market.

Now, as you can see also, we do have serious moments of retracement in this index too. Let’s calculate this one for example – from this high to this low. As you can see, the Dow moved on negative bases for 18.18% from the low of 6,406 to the high of 12,737. Then we continued and made new highs. Again, we corrected here and here but this deep correction and very strong correction also came with fear in the market. Because of the sharpness of the corrective move and the depthness of 8.52% and then again, right now we are in another corrective move or we just in another corrective move for the past few weeks and we corrected 15.26% of the Dow which has been the deepest correction or the deepest corrective move since 2009.

But as you can see, we just made a new high which means that the overall boost structure of the Dow Jones Industrial Average remains and this was just a very deep corrective move because as we saw on the S&P 500, when we hit the 18,000 level of the Dow, we started to trade in a very narrow range. We found some very strong bear pressure because of profit taken from investors that weren’t along from these levels maybe. And because of this bear pressure triggered by the profit taking of long investors, we enter a very deep corrective move that now has come to an end because we finally broke with the Dow structure and basically this is what a Dow is and as you can see, the overall moves in the index are very clean.

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